Residential and commercial property insurance policies always exclude coverage for fire losses in the event the fire was deliberately set by the insured or at the insured’s direction. The language of the exclusion appears in various familiar forms: Regardless of the form, the importance of the exclusion cannot be overstated. If the insurance company has a reasonable, good faith basis to believe that the fire was intentionally set, it can deny the claim.

2. The Role of the Duty of Good Faith and Fair Dealing

Arson investigations do not occur in a vacuum, and it is not (or at least it should not be) the goal of an arson investigation to simply build a case against the insured. Rather, the goal should be to discover what really happened – fairly and objectively. An arson investigation is nothing more than a coverage investigation, and it is well-established that the duty of good faith and fair dealing governs an insurer’s behavior during a coverage investigation.

An insurer has a duty to deal with its insureds in good faith, and a cause of action exists for the breach of that duty. Erie Ins. Co. v. Hickman, 622 N.E.2d 515, 519 (Ind. 1993); County Line Towing, Inc. v. Cincinnati Ins. Co., 714 N.E.2d 285, 291 (Ind. Ct. App. 1999), trans. denied. This duty to deal in good faith with insureds “. . . includes an obligation to refrain from causing an unfounded delay in making payment; making an unfounded refusal to pay policy proceeds; exercising an unfair advantage to pressure an insured into settlement of his claim; and deceiving the insured.” Id. “. . . [A]n insurer which denies liability knowing that there is no rational, principled basis for doing so has breached its duty.” Becker v. American Family Ins. Group, 697 N.E.2d 106, 108 (Ind. Ct. App. 1998). In order to find that an insurance company committed bad faith in a particular case, a jury ultimately must find from the evidence that the company had “a state of mind reflecting dishonest purpose, moral obliquity, furtive design, or ill will.” Colley v. Indiana Farmers Mut. Ins. Group, 691 N.E.2d 1259, 1261 (Ind. Ct. App. 1998).

“Indiana has long recognized that there is a legal duty implied in an insurance contract that the insurer must deal in good faith with its insured. This duty is breached when an insurer fails to settle a claim that could not in good faith be disputed.” Liberty Mutual Insurance Co. v. Parkinson, 487 N.E.2d 162, 164 (Ind. Ct. App. 1985). The duty to act in good faith includes, but is not limited to, four types of obligations: “to refrain from (1) making an unfounded refusal to pay policy proceeds; (2) causing an unfounded delay in making payment; (3) deceiving the insured; and (4) exercising any unfair advantage to pressure an insured into a settlement of his claim.” Erie, 622 N.E.2d at 519.

The ultimate claim decision is only one of the four (4) types of obligations described in Erie, and as the Indiana Supreme Court has made clear, a claim for bad faith may lie even if there is a good faith coverage dispute. In Monroe Guaranty Insurance Company v. Magwerks Corporation, 829 N.E.2d 968 (Ind. 2005), the Indiana Supreme Court held that an insurance company’s “conduct leading up to and including the issuance of the denial letter” may rise to the level of bad faith. Id. at 977. The Magwerks case stands for the proposition that even if there is a “good faith dispute over whether coverage did or not exist”, a claim for breach of the duty of good faith and fair dealing must still be submitted to the jury if there is evidence that the conduct of the insurance company leading up to the denial breached the duty. Id.

The public policy interest served by allowing bad faith claims against insurance companies to be heard is to discourage insurers from denying legitimate claims on the theory that they would only be liable for contract damages. Patel v. United Fire & Cas. Co., 80 F.Supp.2d 948, 959 (N.D. Ind. 2000). “. . . [T]he goal of Erie is to permit plaintiffs in bad faith actions to recover damages beyond those traceable to the contract, including punitive damages.” Id.

Given these authorities, it is clear that even if an insurance company has a legitimate basis for conducting an arson investigation as part of its coverage determination, it must always consider its duty to the insured while handling the investigation in the context of the pending claim. The investigation should not result in undue delay in making the claim decision; it should not involve any deception of the insured or unfair or oppressive conduct. And, importantly, an insurance company cannot insulate itself from bad faith liability by conducting an investigation in a manner that is calculated to construct a “pretextual basis” for denial of the claim. See, e.g., State Farm Fire & Cas. Co. v. Simmons, 963 S.W.2d 42, 44; 1998 Tex. LEXIS 30, **6 (Tex. 1998). The goal must always be the truth and to find coverage for the insured if possible, not to manufacture a pretextual basis to deny – or delay payment of – the claim.

3. Arson Immunity Statute

The operative provisions of the Arson Immunity Statute provide:

(c) A person who acts without malice, fraudulent intent, or bad faith is not subject to civil liability for filing a report or furnishing, orally or in writing, other information concerning a suspected, anticipated, or completed fraudulent insurance act if the report or other information is provided to or received from any of the following:

(1) The department or an agent, an employee, or a designee of the department.

(2) Law enforcement officials or an agent or employee of a law enforcement official.

(3) The National Association of Insurance Commissioners.

(4) Any agency or bureau of federal or state government established to detect and prevent fraudulent insurance acts.

(5) Any other organization established to detect and prevent fraudulent insurance acts.

(6) An agent, an employee, or a designee of an entity referred to in subdivisions (3) through (5).

(d) This section does not abrogate or modify in any way any common law or statutory privilege or immunity.

I.C. § 27-1-3-22 (c) and (d) (Emphasis added). A corollary of this provision is that if the information is provided in bad faith or while the person is acting maliciously or with fraudulent intent then the immunity does not apply. It is here where the pitfalls are found.

4. Pitfalls and Pretext

Unfortunately, many fire investigations still result in a finding that the fire was “incendiary” based on what one renowned fire investigator, Gerald Hurst, Ph.D., has called “garbage fire forensics.” These findings include, but are certainly not limited to:

The investigator claims to be able to tell from the burn pattern on the floor that an accelerant was poured;

The investigator claims the fire burned too hot, or too smoky, or too quickly not to have been accelerated;

The investigator finds that all electrical causes were eliminated in a totally burned building;

The investigator states that the insured behaved unnaturally during or after the fire.

Any decision to deny a claim based on a report containing such bogus claims is likely to be challenged in court, and the reliance may be used to claim the insurance company acted in bad faith. The “science” behind these bogus findings has long-since been debunked, and the insured will argue that it is not reasonable for the insurance company to rely on any report containing such nonsense as an allegedly good faith basis to deny a claim.

Another common error occurs when the insurance company SIU investigator seizes the opportunity to have the state or local authorities investigate the insured with the hope that the authorities will make a determination that the fire was incendiary, thus giving his or her employer a basis to deny the claim.

It is common and expected for SIU investigators to work closely in tandem with the State Fire Marshal when investigating “suspicious” fires. But this situation is fraught with peril for the insurance company. The duty of good faith and fair dealing requires that the insurance company keep the insured’s interests in mind at all times, including during the arson investigation. Yet the overwhelming temptation during an arson investigation seems to be to provide enforcement officials with only those materials that tend to prove the insured’s guilt. If the insurance company’s investigator influences the authorities to change their conclusion or adopt the investigator’s conclusion as to the origin and cause of the fire, and if the insurance company’s investigator routinely works primarily for insurance companies, and if the investigator turns out to have missed important evidence or used inappropriate methodology, it is an easy argument for the insured to make that the investigation was merely an attempt to manufacture a claim defense. In a phrase, the SIU went too far.

For further information about the proper role of the arson investigation in the context of an insurance claim, contact Mike Schultz or Jim Buddenbaum at Parr Richey Obremskey Frandsen & Patterson LLP. www.parrlaw.com (317) 269-2500.